Tuesday, May 17, 2005

Serious Business

It’s been amusing, I admit, to report on Overstock.com CEO Patrick Byrne in these pages.

After all, how hard is it to poke fun at a guy who touts his new auction site as taking off “far faster” than eBay, only to have it hit the proverbial wall, and then says “This may become a long war of attrition with eBay”?

Of course, it’s deeper than just “poking fun.”

From “The Mystery of the 38 Diamonds,” in which we broke the story that Overstock had in fact wholesaled a slug of diamonds rather than sell them one at a time on its “Build Your Own Jewelry” site…through our fictional “Grandma” and her quest to untangle the “decrapitation” of what Byrne had previously touted as Overstock’s “scaleable” and “leading edge” technology, we have, in my opinion, exposed plenty of faulty wiring capable of sparking a short circuit in a company that some on Wall Street still believe is firing on all cylinders.

But now it gets serious.

The Overstock first quarter 10Q came out last week, and, as with the 10K, it contains facts not disclosed in Patrick Byrne’s shareholder letters, press releases, or earnings conference calls with Wall Street, relating to Overstock’s diamond purchase—the “steal of a lifetime.”

On January 28th, 2005, Overstock.com CEO “Doctor” Patrick Byrne described the diamond purchase this way during the company’s earnings call:

We did do a very large diamond buy, sort of a deal of a lifetime diamond buy at the end of the year.

Nobody questioned him on it at that time.

On April 22nd, 2005, Byrne described the diamond purchase in more detail, explaining it as an opportunistic, “overnight” deal that came to Overstock via “a friend of a friend” and was turned around in the space of two weeks.

First, in his shareholder letter on that date, Byrne wrote to investors:

We got lucky with a diamond buying opportunity that came to us just before we launched DYOJ [Design Your Own Jewelry, launched January 28th, 2005].

Second, during the conference call on that date, Byrne said:

1. “This deal came about because two people in the diamond business were splitting and they asked a friend of mine to value the inventory. Actually that’s a friend of a friend…. And they were having a nasty split.”

2. “They called…and we went in and said yes, we will pay it. We paid 7.2 million and I think we took a turnaround the next two weeks [sic]. So we came up with a wire for 7.2 million and got it. And it was on (an) overnight basis.”

3. “That’s how we got the diamonds. And we could I’m sure flip them…for 8 million. We can probably piece them out in fairly large blocks for 8.5 million, but instead, we decided to sit on it.”

4. “It is with a colleague, not a shareholder partner…but it’s with somebody we’ve done business before—quite a bit of business…So that’s the story of the diamonds.”

Yet based on Overstock’s own SEC filings that is not the whole story of the diamonds. Based on Overstock’s 2004 10K and recent Q1 2005 10Q filing, the story of the diamonds really began in August of 2004, when Overstock established the mechanism by which it would buy up to $10 million worth of inventory.

This is how Overstock described the set-up for the diamond purchase in the 10Q that came out Friday:

1. In August 2004, the Company entered into an agreement which allows the Company to lend up to [$10 million] to an entity for the purpose of buying inventory, primarily to supply a new category within our jewelry store which allows customers purchasing diamond rings to select both a specific diamond and ring setting.

2. In November 2004, the Company loaned the entity [$8.4 million].

In plain English, Overstock.com set up an agreement with a legal entity to make the diamond purchase in August, and loaned money to that entity in November.

Here we go again…Patrick Byrne tells shareholders the company did the diamond deal “at the end of the year.” He says it “came to us just before we launched” on January 28th, 2005. He says the deal’s “turnaround” took “two weeks” after “they called” and “we went in and said yes.” He tells investors “we got lucky.”

Meanwhile, over in the 10Q…Overstock appears to have prepared for the deal in August, well before the rainbow broke through the cloudy skies and planted the magical pot of diamonds into Patrick Byrne’s lap “at the end of the year.”

But here’s the capper: Overstock apparently does not own the company that owns the diamonds. Overstock merely lent it money—$8.4 million, for which it receives 3.75% annual interest and 50% “of any profits of the entity”—due next year.

It appears, based on the 10Q, that Overstock simply has a ten year option to buy 50% ownership of the company.

So many questions, so little information.

But instead of me asking the questions, I’m going to let you, our readers, post the questions that we would like to see Overstock.com, or Patrick Byrne, or Wall Street’s Finest answer.

Remember, this is not a message board: no infantile message board language, no fluff. Just the questions this disclosure should raise.

Have at it.

Jeff MatthewsI Am Not Making This Up

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations.

27 comments:

So you never did buy the diamonds , correct ? You just lent these people money on the cheap and got a option to buy 50% , correct ? At what price ? Is this entity up forsale now ? If so , are there any offers ? How are these people ? Going to answer questions about this ? Lawsuits coming ?

What is the advantage to lending an outside entity money to buy the inventory vs doing it yourself?

Your specialty seems to be buying inventory at reduced prices, marking up the inventory and then selling it. What makes diamonds so different that you have to use an outside source to dilute your profits?

You are clearly a well-spoken and erudite man -- noted by many to be quite the wordsmith. So, clearly you understand the power of words and the message they convey.

How then do you reconcile the verbiage and terminology used to publicly describe the transaction, with that of the official filings?What were you attempting to accomplish by describing the arrangements in ways that were inaccurate at best, and misleading at worst?

Contrast "We did do a very large diamond buy," "a diamond buying opportunity," and "We paid 7.2 million" with

"...allows the Company to lend up to [$10 million] to an entity for the purpose of buying inventory," and "... "Company loaned the entity [$8.4 million]."

Please explain your motive for obscuring the true nature of the transaction. And please do not say that you simply chose your words poorly. Whatever your shortcomings might be, word usage is not one of them.

Do you or anyone you are related to, or, does anyone in the management or on the board of OSTK have a relationship, material or not with this variable interest entity that has purchased diamonds on your behalf?

Why do you need to hold diamond inventory when other on-line retailers do not have the expense of inventory exposure?

He used infantile message board language for the umpteenth time, despite a ban on such language from this site. He also used his old "Deliverance" line for the fourth time, despite the fact that it was not worth repeating after the first time. Nothing he has said about OSTK from Day 1 has added value to the fundamental side of the story, so nobody is missing anything, but if anybody has any questions about the Six-Degrees-Of-Separation type conspiracy links he sees in all this, his prior multiple posts on the topic remain for your review.

I will be assembling the questions we would like to see actual Wall Street analysts--if they still exist--ask Overstock.com, once they finish their non-fat two-pump no-whip light-foam double-cup mocha lattes.

So anybody with anything else for Patrick and the Gang, let me know here.

Yup right on cue. Jeff, does care to comment on the things I said but rather since it's against his "grain", chooses to delete. There's a funny post going around the net on the whole gang (including Jeff). I'll try to dig it up and repost. I'm sure it'll last a few minutes before Jeff hits the delete key.

BTW Jeff- Again, why don't you call into the CC instead of expecting someone else to do it (and bashing them no less)?

Many a truths have been said in jest...

---------

PROFILE:

Syndicate: Rocker Partners

David Rocker aka The Dwarfy Donthe mastermind behind the trading strategy of Rocker Partners, David is a known large short seller in the stock market community. it is rumored he once naked short sold his mom to an undercover SEC agent, but all charges had to be dropped when Reg SHO was introduced and grandfathered in all his prior violations. lucky bastard.

Marc "Canary" Cohodes aka Lawsuitstill visibly upset from his parents misspelling of his name, Marc would turn you over to the fedz faster then you could say "are you kidding me?". in fact, he is not kidding. he purportedly once filed a lawsuit on a man that simply asked him if he had the time. "get your own rolex you bum!", he scoffed, as the poor individual was taken away in handcuffs!

Dow JonesCarol "Hedgefund Honey" Remonddon't bother buying this vixen a drink, she'd just assume bash your head in with her keyboard and a few choice words. unless, of course, you belong to a hedgefund. in which case she'll turn over faster then a french poodle on graduation day of her obedience course.

BarronsBill "Weatherman" Alpert aka ALPOsimply put... stay clear of this joe. it's difficult to know how your words will be interpretted by bill. a simple phrase like "how's the weather", depending upon the day, could be interpretted as "hey your zipper's down" or "you f'ing cock-a-roach... i'll kill you will my bare hands."

Street.comJim "The Grocer" Cramerafter graduating from harvard with a law degree, Jim enrolled in a 6 month course on debating taught by famed comedian Sam Kinison (god rest his soul). EVER SINCE, JIM HAS HAD A DIFFICULT TIME KEEPING HIS VOICE DOWN. "THE GROCER", CLAIMED TO HAVE MET MR. ROCKER ONLY ONCE AT A LOCAL SUPERMARKET IN THE PRODUCE SECTION. AN ODD ADMISSION, SINCE MR. ROCKER HOLDS 2 MILLION SHARES OF STREET.COM, A COMPANY STARTED BY JIM. DAVID WAS ALSO, AT LEAST ONCE, INTERVIEWED BY JIM ON HIS SHOW.

MarketwatchHerb "lapdog" Greenbergthis guy is a real jewel. his story can be bought for a tootsie roll and a bag of m&m's. this guy would half-truth his grandmother for a nintendo system. fortunately for the syndicate, he's in bed with more newsrags then a 2 bit hooker. his specialty is drive-by journalism, in which he tosses a grenade in the direction of an unsuspecting company and speeds away screaming "and don't bother with the hate mail; they all go to my trash box!"

Ram PartnersJeff "Backspace" Matthewshaving once worked at Rocker Partners and Street.com, Jeff is no stranger to the syndicate. don't cross paths with him on his blog, Jeff will wipe your comments clean faster then a underpaid mcdonalds employee. his affinity towards bashing Overstock's CEO, Dr. Patrick Byrne is widely known where one can expect a barrage of banal observations from Jeff about every 3 days.

Gradient AnalyticsDon "New Math" Vickrey, PHDmuch like Wile E. Coyote, Don is a verified "Super Genious". so intelligent, in fact, no one understands how he arrives at his calculations. incidentally, the last person that tried, drove himself to insantity and is now spending the remainder of his life in a mental institution. irrespective, for a mere 100k, Don will develop a new and incomprehensible accounting model for your company to your liking using very scientific words.

BashersTony "Cut&Paste" Ryals aka Biodog0 aka James Dale Davidsonbeing incapable of having an original thought, Tony defers to cutting and pasting other people's work across various sites on the internet. in part, because of 1) his disability to articulate any rational conclusions on his own and 2) his desire to clog up other people's rational discussions due to jealousy. Some are speculating he is really James Dale Davidson, something Tony spends an inordinate amount of time accusing others of being

The inability of the OSTK bulls to say anything positive about the fundamentals of the company is pretty amazing.

There must be a good reason to own OSTK, otherwise HBK wouldn't have bought 1mm shares. But heck if I can see the reason. Maybe if you let mfairview continue to post sooner or later he might stumble on it.

You called the diamond purchase a “deal of a lifetime diamond buy” and said “We got lucky with a diamond buying opportunity”

This implies that you have no anticipation that future diamond buys will be at similarly advantageous pricing – unless “deals of lifetime” happen frequently (in which case, you have misrepresented this one.)

You further said, “And we could I’m sure flip them…for 8 million. We can probably piece them out in fairly large blocks for 8.5 million…”

Assuming that you are correct in your assessment, let’s take the mid-point of that range and say the stones could be sold for $8.25 million. That is a gross profit of about $1 million on a sales price of $8.25 million – or roughly a 12% margin.

However, since you only are entitled to half of the profit (via the option to buy the “entity” and its profits) your money really only generated a 6% margin (plus the small annual interest of 3.75%)

In your most recent quarterly earnings release you report a gross profit margin of 15% on your normal business activity, and you said that there are “still basis points to be added in shopping margins (setting aside the gain we will see if our high-margin businesses, such as auctions and travel, take off.)” Furthermore, the diamond deal is not one wherein you get your cash back so as to utilize it in Overstock’s traditional business. It is tied up in this “entity.”

It’s actually a shade worse than that – you loaned the entity $8.4 million, part of which they are evidently using for their own overhead purposes. So, not all of the capital you invested in actually going into profit-generating inventory.

And margins will only get worse. The $7.2 million was a never-to-be-repeated “deal of a lifetime,” remember?

So, how is the chance to generate a 6% (or less) margin such a “deal of a lifetime” as to warrant tying up valuable capital that could be used to generate 15% (or better) margins?

What I don't get though.. Is why someone like Jeff spends so much time bashing OSTK when there's really no story here? Ok 1 or 2 segments littered here and there but he's in double digits now in a very compressed timeframe. Me smells a rat and thy name is Jeff.

All my "6 degrees" talk (actually it's 1 degree) raises possibilities as to why this man is doing what he does. Is there really a story here with the OSTK rants or is Jeff :

1) A bit emotional. 2) Has alterior motives. I, again, note that Rocker did call in to the 3rd Q CC to have it out with Byrne. While Jeff thinks it's odd for Byrne to publicly extoll the corruptness of "Wall Street" (realize his whole family does this for a living so he might know a little something about something here), he finds no problem with David Rocker, his former employer (also a big short on OSTK) calling in to yell at Byrnes in a Conference Call?

BTW Jeff, it seems you're stilled annoyed about me pointing out your overuse of the line "not a face card in the bunch" in your speeches-- I haven't seen it from you in awhile. Your accusations of my "Deliverance" line is merely because I've reposted something verbatim. You've yet to acknowledge it as to whether it's true or false. I welcome the opportunity to clean it up with your help!

If it were 1999, 100% revenue growth, "bordering profitability" and yada yada yada would qualify as strong fundamentals. It's not though, and so based on the fundamentals, OSTK trades at 1.23x EV/Sales, which seems a bit rich for a closeout retailer with razor thin margins. Admittedly, with 100% yoy growth, that projects to '05 revs of $1B, which leads to a forward multiple of .7x EV/Sales, probably closer to the proper multiple. The problem as I see it is that even with great top line growth, the bottom line hasn't changed. The company has turned in 2 profitable quarters in its public life, and actually lost more money in Q1 05 than it did in Q1 04, on 2x the revs. Besides that, Dr. Byrne has not won himself any points by continually overpromising and under delivering.

As to Jeff's "motive", why do you care? Why do you even come to this blog? How many articles in the press day in and day out quote money managers who are long a stock, or analysts who are touting it, or management who is obviously bullish?

Methinks you are long NFI and OSTK, so are thus mad at Rocker Partners who you accuse of "naked" short selling, even though they are a long established fund who never could have made it this far doing something illegal for a living. Jeff used to work at Rocker, is a know fund manger who is willing short stocks, and so you assume he and Rocker are collaborating to "take" down stocks that they have short positions in. I would not be surprised if they do share ideas, both long and short, much as long only managers share their ideas with each other EVERY day. The only difference is that you're long a stock they may be short, and you take great offense to this, given that you are clearly an investor of mungersque talent.

As suggested by "gvtucker," I'll leave that last winner from "mfairview" up, for now.

The lack of data permeating his frequent posts certainly illustrates the quality of the long side of the OSTK debate, which reminds me of the quality of the long side of the Media Vision debate, the Lernout & Hauspie debate, the Regina debate....

In fact, it illustrates the long side of the debate surrounding pretty much every true scam I've ever run across in 25 in this business.

In the meantime, the rest of us have day jobs, but please post your best Overstock-diamond-related questions here and I will summarize and reprint tomorrow...along with some juicy new verbiage from the master himself.

Seems Patrick was telling his story at JP Morgan yesterday. And quite the story it was!

Mfairview's comments always amuse me. Rather than address real issues, he/she prefers to sling mud and make false accusations. Further, his/her accusations never make any sense and can be easily debunked. I can't speak to the motives of Mr. Matthews, Mr. Rocker or any of the others that Mfairview disparages in his infantile commentaries. But I can speak to the laughable comments that he makes about me and my firm, Gradient Analytics.

While Mfairview's comments about me are, in a way, a backhanded compliment of sorts (not requiring a response), I feel that I must point out one obvious flaw in his attempt to lay out this vast and ridiculous conspiracy theory. My firm currently serves over 100 professional money manager clients who take a variety of our products, from quantitative models to qualitative research. For that matter, a majority of our clients are long-only managers who cannot short stocks - period. If, as Mfairview suggests, I were to cater to one specific clientele, my economic returns would be severely diminshed. It is simple economics. I cannot grow a business that caters to just one small subset of the investing universe.

As for our coverage on OSTK, we continue to believe that the firm's accounting choices are aggressive and that its business model is flawed. The fact that Mr. Matthews, Mr. Rocker, and Mfairveiw's other alleged conspirators all have bearish views of OSTK should not come as any surprise. Patrick Byrne has set himself up for criticism and ridicule by his business decisions, personal style and a barrage of statements that appear to be contradictory. Thus, in the spirit of Occam's Razor, I offer a much simpler explanation. Mfairview's list of alleged conspirators are all critics of sorts and Patrick Byrne's behavior attracts critics. Is it unusual that a person who's style attracts critics would have several critics questioning his words and actions? Does it really take a vast and complex conspiracy involving short-selers, naked short selling, journalists, analysts, the SEC (don't forget the so-called "captured regulators"), and just about everyone except the Pope to explain the criticisms of OSTK and Mr. Byrne? Oh what would Occam say of such nonsense?

Vickrey of Gradient asks what Occam would say about OSTK. Occam would first point out the diff b/w who's and whose, and then, more important, would suggest that Vickrey try to rebut, point by point and in sufficient detail, the numerous critiques by experts (like Howard Hill) of his firm's error-riddled report on NFI.